Of all the ways to buy real estate, leasing with an option to buy is one of the most creative alternatives if your credit is not as strong as it could be. Tenants who are interested in buying, but are not currently in a position to buy can use it to lock in a price against future price increases. This is also a tool that can be used by owners and property managers to attract quality tenants. And it is used by owners with property that, for whatever reason, is not renting or selling at the price they want.
The Option to Buy Agreement
Leasing with an option to buy is exactly what it sounds like – a renting tenant signs the agreement with a landlord stating that the tenant may buy the property at the end of a prearranged time period. The owner is obligated to sell at the option price, however, the tenant is NOT obligated to buy the property. But when a lease-purchase is exercised, the buyer is obligated to purchase at the end of the rental period.
A common misconception is that once a landlord signs this type of agreement, he has to sell the property to the tenant, or that the tenant has an absolute right to the property. Not so – the tenant can buy the property only if the landlord exercises the option to sell.
Pros and Cons when Leasing with Option
There are pros and cons with both sides of this coin. The property owners are in a secure position with a lease with option to buy contract because they still own the property. Sellers have rental income and get tax deductions. For buyers, the biggest draw is that they get more time to qualify for their financing.
Before entering into this type of agreement, a written document needs to be be drawn up that includes all the terms before the tenants move in. Because the tenant and the seller are entering into two separate legal matter, a rental agreement and a contract to purchase - it’s a good idea to have an attorney involved to make sure that all bases are covered.
The option needs to be recorded with the county clerk to put others on notice of the tenant's rights, preventing the seller from selling the property to another buyer.
The lease agreement should also include a clause that terminates the option to buy if the tenant violates the lease or gets evicted before closing the agreement to purchase.
Consider these issues that should be addressed in the contract:
Within your lease agreement, a security deposit should be required. Since some states don’t allow the deposits to surpass one month’s rent, there could be an earnest money deposit requested to be kept in escrow until such time as the option is exercised.
Usually, the purchase price is in the original lease-option agreement. The price should be set according to today’s market, not in the future when the option may be exercised. This could be good news or bad news, depending on whether real estate prices increase or decline during the lease.
Another option is the “right of first refusal,” which means that the tenant has the option to purchase the property at a price predetermined at the time of sale as opposed to the time of the agreement. The tenant may also have the right to purchase the property at the price offered to the landlord by another buyer.
An option to buy doesn’t give the tenant legal title to the real estate. The tenant becomes a purchaser only upon exercise of the option, when the landlord-tenant relationship ends and the option becomes a binding contract of sale.
This is a unique feature. The tenant usually pays above-market rent for the property, but a portion is credited toward the purchase price if the buyer decides to exercise the purchase option. For example, on a house that rents for $1,500 per month with a 33 percent rent credit, $500 per month goes toward the down payment when the option is exercised. If the tenant decides not to buy, they don’t get the rent credit money back. This is one of the biggest incentives for a tenant to buy.
A due-on-sale clause may prevent a buyer from assuming the mortgage by permitting the bank to call the mortgage due when the property is sold. The terms of the seller’s mortgage and the lease agreement determine whether the due-on-sale clause will be established by the lease with an option to buy.
For more information on this subject, or any real estate questions, please contact me.